The failure to allow Petrobras to raise domestic gasoline and diesel prices in line with world prices prompted its first loss in 13 years in the second quarter of 2012, and added more than $8-billion in 2012 losses at its refining unit. (SERGIO MORAES/REUTERS)

The failure to allow Petrobras to raise domestic gasoline and diesel prices in line with world prices prompted its first loss in 13 years in the second quarter of 2012, and added more than $8-billion in 2012 losses at its refining unit.(SERGIO MORAES/REUTERS)

Just five years ago, Brazil’s mostly “green” energy landscape was the envy of nations dependent on dirtier sources of power and the pride of a government that believed it was leading the country to economic superpower status.

Three-quarters of electricity came from renewable hydro power and the main automobile fuel was home-grown sugarcane ethanol. Plus, Brazil had just found massive oil fields off its coast, putting it on a path to become the world’s No. 3 oil producer after Russia and Saudi Arabia by 2020.

Market View

Today, the outlook is much darker. Oil output is falling, ethanol production has plunged, and fears have recently returned of electricity rationing that could further depress a stagnant economy and embarrass President Dilma Rousseff.

What went wrong?

Analysts and investors say the current troubles were bred from excessive optimism during the rosy years, when Brazil’s government tried to take greater control of the energy bonanza and ended up scaring off investors.

“Brazil has become a victim of the politics of economic plenty,” said Christopher Garman, Latin American director of the Eurasia Group, a New York-based political risk and economic consulting group.

“When things were going so well for Brazil, and after they discovered oil, the administration was infused with a sense of hubris,” he said. “They thought they had more room to conduct an active industrial policy and change the regulatory landscape.”

Ms. Rousseff recently dismissed fears of energy rationing as “ridiculous,” despite some energy analysts and investors who say the possibility is quite real.

One of the root problems is beyond her or any government’s control: One of the worst droughts in decades in parts of Brazil is depriving dams of the water they need to generate electricity.

Brazil’s recent efforts to diversify its electrical grid – which have earned it plenty of criticism from environmental groups – may in fact end up protecting the country from the widespread rationing most recently seen in 2001. Hydro power now accounts for about two-thirds of electricity generation, down from about 80 per cent in 2005.

Yet the troubles go much deeper than just a few impaired dams. Brazil’s whole energy sector is riddled with inefficiencies and investor anxiety, from state-owned colossus Petroleo Brasileiro SA, known as Petrobras, to the recent multibillion-dollar losses in valuation at electrical companies such as Cemig and CESP.

The stakes are particularly high for Ms. Rousseff, who was elected president in 2010 in part because of her perceived competence in managing the energy sector.

As energy minister from 2003 to 2005, she was charged with making sure Brazil never experienced a big shortage again and with paving the way for the country to become an oil superpower in decades to come.

The problems in the sector also reflect a broader complaint from investors – that heavy-handed government intervention under Ms. Rousseff has increased the role of the state at the expense of the private sector. As a result of that and other problems, Brazil’s economy likely grew less then 1 per cent in 2012, one of the lowest rates in Latin America.

GOOD INTENTIONS GONE BAD

In recent years, Ms. Rousseff oversaw the rewriting of a decade-old legal framework for oil production, blocked efforts by Petrobras to raise gasoline and diesel prices, and forced Centrais Eletricas Brasileiras, a state-led utility, to cut power rates in exchange for hydro concession renewals.

Nearly all those measures backfired in one way or another.

The new oil law, passed in 2010, sought to maximize the government’s control of the bonanza expected from the so-called subsalt fields, one of the world’s largest recent oil finds with as much as 100 billion barrels of oil buried underneath a New York-state-sized area along Brazil’s coast near Rio de Janeiro and Sao Paulo.

At current rates of consumption, that would provide enough oil for all U.S. needs for 14 years and all of Brazil’s for a century.

Rather than immediately exploiting the oil and reaping the benefits primarily through royalties, the government hoped to use the subsalt fields as an opportunity to build an entire offshore oil industry.

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